How M&A-spotters can make big bucks
F OR those of us trading the financial markets over the last two years, large mergers and acquisitions may now be a distant memory. Figures from markets analyst Dealogic indicate that acquisition volumes are down 55 per cent in Europe and 61 per cent in the US compared to this time last year. So much has happened since the days of large institutions engaging in an intense and public bidding war that the mere mention of a return to M&A whets the appetites of shareholders and traders alike.
With the economy continuing to show signs of a recovery, many are now convinced that companies will become less concerned about stabilising their balance sheets and will now look for growth through M&A. Scores of investors have viewed the recent flurry of bids and subsequent deals – including Kraft Foods and Cadbury or Xerox and ACS to name but two – as indicating that the M&A recession has hit a bottom and may return to growth soon.
So if M&A is on the rise, how can spread betters try to spot M&A potentials and take advantage of market speculation? If they are good at picking the right ones, M&A can be a spread better’s dream. Share prices often rise as much as 30-40 per cent on the day the first rumours or confirmations of bids enter into the public domain.
FRUITFUL TALENT
When news first broke in November 2007 that Rio Tinto had rejected a $50bn offer from BHP Billiton, Rio’s share prices rallied almost 32 per cent. The potential for speculators to make tremendous gains from predicting future mergers or acquisitions is a talent in short supply but could well be a very fruitful one.
Historically, M&A speculation tends to weaken the share price of the bidder and boost the share price of the subject. When Kraft made a $17.6bn offer for Cadbury, Kraft’s shares fell 7 per cent while Cadbury’s shares rallied as much as 42 per cent.
One potential tactic is to look towards failed M&A deals from the past that may start to resurface. Several high profile multi billion pound mergers have fallen through over the last five years and these could well come back to the fore now that valuations have dropped. In this sense, BHP Billiton’s pursuit of Rio Tinto and other high profile failed bids of recent years, such as Xstrata’s aborted move for Lonmin, spring to mind.
Picking a specific stock that looks set to be bid upon is a tough ask but there are alternative strategies for spread betters to pursue. You do not necessarily have to pick out a specific stock, but rather you could choose a sector that may be subject to bid speculation. This was evident last week when Legal and General was the subject of bid speculation from Resolution causing the life insurer’s sector to rally over 10 per cent in three trading days.
RISK/REWARD
It is important that spread betters also be mindful as to when to exit positions, as share prices can go down just as much as up depending on the success of a bid.
In 2008, Rio Tinto’s share price fell 42 per cent on the day that BHP walked away from its pursuit of the Australian miner. Therefore, spread betters should look to manage their risk as a protection in case bids fail.
Investors should use guaranteed stop losses which will protect them even if a stock price gaps 40 per cent lower.
So keep your wits about you. If M&A does pick up, we could see some serious volatility. And as we all know, that is a spread better’s best friend.
Joshua Raymond is market strategist at City Index.